Question

On January 1, 2019, Billips Corporation purchased equipment having a fair value of $72,054.94 by issuing a $90,000 note, payable in three $30,000 annual installments beginning December 31, 2019.

Required:

Prepare:
a. the journal entry to record the purchase of the equipment.
b. a schedule to compute the annual interest expense.
c. the journal entries to record yearly interest expense and note repayments over the life of the note.

Answer 1

a. Journal entry: Equipment $72,054.94; Notes Payable $72,054.94. b. Annual interest expense: Interest Rate = 24.69%. c. Journal entries: Year 2019 - Interest Expense $17,567.06; Notes Payable $30,000. Year 2020 - Interest Expense $16,864.41; Notes Payable $30,000. Year 2021 - Interest Expense $16,135.59; Notes Payable $30,000.

Step-by-step explanation:

a. To record the purchase of the equipment, the journal entry would be:

Equipment $72,054.94

Notes Payable $72,054.94

b. To compute the annual interest expense, we need to calculate the annual interest rate. Since the note is for $90,000 and the annual installments are $30,000, the interest rate can be calculated as follows:

Interest Rate = (Total Payments - Principal) / Principal

Interest Rate = ($90,000 - $72,054.94) / $72,054.94

Interest Rate = 0.2469 or 24.69%

Now, to compute the annual interest expense:

Annual Interest Expense = Outstanding Balance x Interest Rate

c. The journal entries to record yearly interest expense and note repayments over the life of the note would be:

Year 2019:

Interest Expense $17,567.06

Notes Payable $30,000

Year 2020:

Interest Expense $16,864.41

Notes Payable $30,000

Year 2021:

Interest Expense $16,135.59

Notes Payable $30,000

Answer 2

a. the journal entry to record the purchase of the equipment.

January 1, 2019, equipment is purchased

Dr Equipment 72,054.94

Dr Discount on notes payable 17,945.06

Cr Notes payable 90,000

b. a schedule to compute the annual interest expense.

Since we are not given any type of interest rate to compute the amortization of the discount of notes payable using the effective interest method, I will use straight line amortization. Amortization of interest expense per year = $17,945.06 / 3 = $5,981.68

• interest expense for year 1 = $5,981.68, carrying value of discount on notes payable = $11,963.38
• interest expense for year 2 = $5,981.68, carrying value of discount on notes payable = $5,981.70
• interest expense for year 3 = $5,981.70.

c. the journal entries to record yearly interest expense and note repayments over the life of the note.

December 31, 2019, accrued interest expense

Dr Interest expense 5,981.68

Cr Discount on notes payable 5,981.68

December 31, 2020, accrued interest expense

Dr Interest expense 5,981.68

Cr Discount on notes payable 5,981.68

December 31, 2021, notes payable is paid off

Dr Notes payable 90,000

Dr Interest expense 5,981.70

Cr Cash 90,000

Cr Discount on notes payable 5,981.68